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Mortgage
Glossary | All About Adjustable Rate
Mortgages | Getting Your
Finances in Order
Your Credit History | When
Should You Pay Points on a Loan? | Saving
for the Down Payment
Closing Costs
When it
comes to comparing interest rates for a mortgage loan, homebuyers
often have the option of choosing a loan with a lower interest
rate by paying points. Simply put, a point is equal to 1 percent
of the loan amount. For example, with a $100,000 loan, one
point equals $1,000. Points are usually paid out-of-pocket
by the buyer at closing.
Paying
points may seem attractive, because a lower interest rate
means smaller monthly payments. But is paying points always
a good idea? The answer generally depends on how long you
plan to stay in the house. Let's look at an example:
Bob and
Betty Smith are shopping for loan rates on a $150,000 home.
Their bank has offered them a 30 year loan at 7.5 percent
with no points. This works out to a monthly payment of $1,049.
However,
their bank has also offered them a loan at 7 percent if they
agree to pay 2 points (or $3,000). At this lower rate, their
monthly payment drops to $998, or a savings of $51 per month.
By dividing
the amount they paid for the points ($3,000) by the monthly
savings ($51), we see that they will have to own the house
for 59 months (or just under 5 years) before they will start
to see savings as a result of paying points. If Bob and Betty
plan to stay in the house for many years, then paying points
could make good sense. But if they see themselves moving to
another house in the near future, they'd be better off paying
the higher interest and no points. (Note: for simplicity,
the above example does not take into account the time value
of money, which would slightly lengthen the break-even time.)
Can
you deduct points on your income taxes?
In the United
States, one side benefit
of paying points on a mortgage loan is that they are fully
tax deductible for the same tax year as your closing. However,
this does not apply to points paid for a refinance loan. For
refinances, the IRS requires you to spread out the deduction
over the life of the loan. For example, if you paid $5,000
in points for a 30-year refinance loan, you can only deduct
1/30 of the $5,000 each year for 30 years. If you pay off
the loan early, though, you can deduct the remaining amount
that tax year.
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